The S&P 500 index has recently reached unprecedented heights, marking the third year of a robust bull market. However, it's important to note that not all stocks have shared equally in this surge. Over the past few years, large technology companies have disproportionately influenced the S&P 500's value, particularly due to their investments and innovations in artificial intelligence (AI). This has led to a significant growth in the market capitalization of these companies.

Investors have anticipated that the substantial AI investments will yield long-term benefits, such as accelerated earnings growth, and have accordingly increased the valuation of these major spenders based on lofty expectations for the future. Conversely, companies that lack the capital to invest heavily in AI or are less directly impacted by AI advancements have not seen their valuations rise to the same extent.

However, an indicator suggests that the trend of the largest companies growing at a rate that significantly outpaces the rest of the market may be nearing its end. This presents an excellent opportunity for investors to capitalize on the next phase of stock market growth.

A significant warning signal for investors is the increasing concentration of the market in just a few major winners. For instance, the three largest companies globally—Apple, Nvidia, and Microsoft—now account for over 20% of the entire S&P 500. S&P Global uses a metric to gauge market concentration by comparing the average market capitalization of the S&P 500 to the index-weighted average, which gives more weight to companies with larger market caps. As market concentration increases, the ratio of the weighted average to the unweighted average rises.

At present, this ratio stands at approximately 10 to 1, which is higher than any level recorded by S&P Global since 1970. This is a significant warning sign, indicating that investors in a typical S&P 500 index fund may not be as diversified as they believe. Moreover, if the concentration trend reverses, which it often does, investors could face a prolonged period of subpar performance. Market concentration is one of the factors contributing to Goldman Sachs' forecast for a decade of minimal market returns.

Predicting when the market will begin to shift away from the large tech names that have driven the S&P 500 higher over the last few years is impossible. However, there are indications that this shift could happen sooner rather than later. Not only has the market reached an all-time high in concentration, but economic factors may also start to favor smaller businesses.

As the Federal Reserve raised interest rates and tightened the money supply, it magnified the advantage of large tech companies, which could afford to invest heavily in growing their businesses and advancing in artificial intelligence. The opposite could be true in the future. In September, the Fed made its first interest rate cut since 2020, which could signal the beginning of a long cycle of rate cuts over the next few years. The U.S. money supply is already growing at an accelerating pace, which is one of the first signs of a potential reversal in market concentration. This shift could occur as early as next year.

Investors do not need to identify the "best of the rest" in the S&P 500 if they wish to reduce their exposure to the stocks that have driven the market to such high levels of concentration. There is no guarantee that Apple, Nvidia, and Microsoft will not continue to dominate the market for some time. However, investors can decrease their exposure to the largest companies and increase their investment in the smaller constituents of the index by purchasing an equal-weight S&P 500 index exchange-traded fund (ETF).

The Invesco S&P 500 Equal Weight ETF is the most straightforward and cost-effective way to invest in the equal-weight index. With an expense ratio of 0.2%, it is managed to avoid capital gains distributions since its inception. The ETF simply invests an equal amount in every component of the S&P 500, rebalancing every quarter in line with the official index.

Over the long term, the equal-weight index has outperformed the market-weighted index. Naturally, it performs better in years when market concentration decreases and underperforms in years of increasing market concentration. As such, the last five to ten years have not favored the equal-weight index. However, if you believe that the current level of concentration is unlikely to persist, you might consider adding the Invesco fund to your portfolio or reallocating some of your assets to the equal-weight index.